A Guide to Calculating LTV (With Definition and Examples)
By Indeed Editorial Team
Published May 2, 2022
The Indeed Editorial Team comprises a diverse and talented team of writers, researchers and subject matter experts equipped with Indeed's data and insights to deliver useful tips to help guide your career journey.
There are various factors that influence acquiring a property, including the property's price and if you require mortgage loans to fund the purchase. One indicator that financial firms utilize is the loan-to-value (LTV) ratio. Calculating it might assist you in remaining aware of many alternatives while purchasing a property. In this article, we define the loan-to-value ratio, explain when and how to calculate it, and share an example to determine the loan-to-value ratio for combined mortgages.
What is LTV?
The loan-to-value ratio, or LTV, is a financial risk indicator used by financial organizations such as banks, lending institutions, and insurance companies. When represented as a percentage, a high ratio indicates that a loan carries a higher financial risk. In contrast, a low ratio indicates that the loan carries a lower financial risk. Typically, financial organizations employ a loan-to-value ratio to determine whether to accept your loan application after examining mortgages and your home equity credit. In addition, they may require you to acquire private mortgage insurance to reduce their risk.
What is the loan-to-value ratio formula?
You can calculate the loan-to-value ratio using the following formula:
Loan-to-value ratio = (total amount of mortgage / appraised property value) x 100
If you want to determine the ratio for a sum of multiple loans, use the following formula:
Loan-to-value ratio = (current combined mortgage balance / appraised property value) x 100
What is the maximum loan-to-value?
Uninsured mortgages have a maximum loan-to-value of 80%, while insured mortgages have a maximum loan-to-value of 95%. A low loan-to-value ratio indicates that your mortgage lender is more likely to reclaim the whole mortgage balance if you default, even if property prices decline. A lower loan-to-value also provides you with greater options due to the increased equity in your property. Your equity in a property is the value of your interest in the property or the money you can receive after paying your mortgage and the asset's sale.
As a result, a low ratio may enable you to obtain another mortgage or take a loan against your equity, as a home equity line of credit (HELOC). A HELOC is a line of credit secured by the available equity in your property. The property's equity is the difference between the estimated worth of your property and your existing mortgage amount. The Bank of Canada distinguishes mortgages into two categories: low-ratio and high-ratio.
What are low-ratio mortgages?
Low-ratio mortgages or conventional mortgages have a deposit of more than 20%. While mortgage insurance is voluntary, your financial institution may mandate it as an approval requirement. There are no regulatory restrictions on debt-service conditions, the purchase value, or the amortization time.
What are high-ratio mortgages?
Mortgages with a high ratio have a loan-to-value ratio greater than 80%. That suggests that the deposit for a new home was lower than 20%. Loan insurance is mandatory for high-ratio mortgages, like the mortgage default insurance offered by the Canada Mortgage and Housing Corporation (CMHC). Because insured mortgages are less risky for the lending institution or bank, high-ratio mortgages typically have a lower interest rate.
Additional criteria apply to high-ratio mortgages, including debt-service conditions (limits on payment instalments compared to income), an amortization time of 25 years at most, and a property purchase value of $1 million at the highest.
What does your loan-to-value ratio mean?
Financial institutions often use this ratio to determine whether or not to grant you credit. A high ratio can be riskier for a mortgage provider, while a lower ratio may be preferable. As a result, this ratio may also influence your mortgage approval and interest rate.
Your loan-to-value ratio can reduce as you repay the loan. It may also reduce if the value of your property grows. Similarly, your ratio may rise if the value of your property declines. A ratio greater than 100% indicates that the amount you owe on your mortgage is greater than the value of your property. Experts refer to this scenario as "negative equity,” also known as having a mortgage that is "underwater.” Financial institutions consider individuals who have mortgages that are underwater to be more likely to default in payment.
When to determine the loan-to-value ratio
Individuals and corporations can use the loan-to-value ratio when they wish to buy a property. It's usually advisable to consider this ratio before applying for a loan because it might provide insight into the actions necessary to obtain loan approval. For instance, if your ratio is high, you may want to plan for the likelihood that the financial firm may require you to obtain private mortgage insurance.
You can also use loan-to-value when making mortgage payments. Doing this can help you remain updated about alterations to the values used in the calculation. For instance, the appraised value of a property may fluctuate due to factors such as the property's condition, emerging trends in the region, and other changes that may influence the property's value. Your overall mortgage value changes as you make payments toward it, implying that the loan-to-value ratio keeps changing every time you make a mortgage payment.
How to calculate the loan-to-value ratio
You can take the following steps when calculating your loan-to-value ratio:
1. Determine the property's worth and your down payment
You can start calculating your loan-to-value ratio by determining the property's worth at the time of the calculation. For instance, if you're thinking about buying a property and require a mortgage, then you can use the market price or the property's listed value to find out what the appraised value is. If you're currently making payments on the property, you can hire an appraiser to assess it and establish its worth.
For example, if you want to buy a new house, the property value is the purchase cost, while the mortgage amount is the purchase cost minus the down payment. If you're refinancing or changing mortgage lenders, it may also necessitate performing a home appraisal to determine the current market valuation of your house. Refinancing refers to the process of replacing a current debt obligation with another under new terms.
2. Note the current balance of your mortgage
After determining the property's appraised value, you can note the total mortgage payment required. You can derive this figure by subtracting the down payment you're making from the property's total value. Then, you can consider the remaining balance as the current mortgage. For instance, if you own a $200,000 property and can make a $40,000 down payment, your mortgage becomes $160,000 at the time of the calculation. Take into consideration that this value may change over the course of the mortgage's term.
Additionally, you can contact the financial organizations that process your mortgage loan payments to ascertain the entire cost of the loans at the time of the calculation. Because the values change when you make payments, it may be advisable to monitor how your loan-to-value also changes. This monitoring is particularly helpful because having a lower ratio has some advantages, including reduced interest rates on existing loans and a greater possibility of approval for new loans. When calculating loan-to-value, it's typically ideal to have a value less than 0.8 or 80%.
3. Divide your mortgage balance by the appraised value of the property
Once you've determined the total mortgage balance or amount and the property's current appraised value, you may calculate the loan-to-value ratio. For instance, if your property is worth $500,000 and your mortgage balance is currently $350,000, the ratio is as follows:
Loan-to-value ratio = (total amount of mortgage / appraised property value) x 100
Loan-to-value ratio = (350,000 / 500,000) x 100
Loan-to-value ratio = 0.7 x 100
Loan-to-value ratio = 70%
Your ratio is 70%, which is an ideal value. With this ratio, you're unlikely to require private mortgage insurance to reduce the financial institution's risk.
Example of determining the loan-to-value ratio for combined mortgages
Consider the example below to understand how to determine the loan-to-value ratio of two combined mortgage loans:
You're purchasing a home with a total value of $400,000, your down payment for the house is $40,000, and you have two loans. The first loan is $220,000, while the second is $140,000. The combined remaining balance of the two mortgage loans is $360,000. You can now obtain the ratio as follows:
Combined mortgage amount: $360,000
Appraised property value: $400,000
Loan-to-value ratio formula: (combined mortgage amount / appraised property value) x 100
Loan-to-value ratio = (360,000 / 400,000) x 100
Loan-to-value ratio = 0.9 x 100
Loan-to-value ratio = 90%
Since the loan-to-value ratio is high, you may explore the option of obtaining private mortgage insurance so you can receive loan approval.
Please note that none of the companies, institutions, or organizations mentioned in this article are affiliated with Indeed.
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